Notes From Underground: Europe Takes Center Stage (Again)

It is always a pleasure to talk with the Richard Bonugli at the Financial Repression Authority. Like Anthony Cruedele of Futures Radio, Richard is a very astute financial mind, which allows for deep discussions in a longer format. We cover several issues discussed in Notes From Underground so I’m sorry if it seems redundant, but I will say that we take a deeper dive on the issues. The segment taped on Wednesday, January 10 so from a trading perspective the information may be stale. But from an investors’ perspective it will still be relevant as the markets begin to unravel the mysteries of a new year. We dive deeper into Europe as I am certain the continent will provide much of the tinder for market volatility in 2018. This weekend proved the case as several stories from Europe propelled the DOLLAR lower as U.S. markets were on holiday for Martin Luther King Jr.’s birthday.

First, news broke overnight that the Bundesbank was beginning to purchase Chinese yuan to hold as a percentage of its foreign reserves. The purchases of Yuan (renminbi) up to this point are minuscule but it is the mere suggestion that sent the EURO currency almost another one percent higher today. The sense is that it reflects DIVERSIFICATION away from the U.S. dollar’s role as the global reserve currency. As Chou En Lai might say: Far too early to tell. Regardless of the veracity of Bundesbank intentions the EURO is approaching a critical resistance area that I have discussed in previous blog posts. The price bar (as shown on CQG) from the week of July 23, 2012 is important because that was the week ECB President Mario Draghi invoked his authority and proclaimed he would do whatever it takes to preserve the EURO currency.

The range that week was 1.2390 to 1.2042 with the weekly close at 1.2320. The cash high today was 1.2297. If the EURO can climb above 1.2390 and close out a week above that level I would opine that a new leg lower in the U.S. dollar is in the offing, especially since the EURO is rallying even though the area is plagued with numerous political problems. NOTES FROM UNDERGROUND has not been bullish the dollar for almost 12 months but I am expecting increased volatility as the political environment in Europe becomes more complex.

Secondly, the weekend brought news of a grand-coalition formation in Germany between the CDU/CSU/SPD in an effort to prevent a new election being called and Chancellor Merkel suffering an outright defeat at the polls. SPD leader Martin Schulz fell on his proverbial sword and came to an agreement with Chancellor Merkel to assemble a governing plan for the new and improved Grand Coalition. The concord has to be approved this coming Sunday by the entire SPD membership. There is a sense that the youth and more radical wing of the Social Democrats may not move to approve and force Merkel to either govern as a minority part or call new elections. The last thing Merkel or other European nations desire is for new elections that many fear will raise the status of the AfD (alternative-right) German party. The established political camps are pursuing a full press to get all dissidents to acquiesce to the status quo arrangement.

In Monday’s Financial Times, opinion writer Wolfgang Munchau has an important piece: “A German Coalition Deal to Radically Reshape Europe.” Munchau points out that the European theme is the basis for the CDU/SPD political coalition but it is a dangerous tact for both parties as neither one garnered enough votes to take Germany down a radical new path. In the coming vote for the SPD Munchau raises a key question: “Does their enthusiasm about European integration outweigh their hostility toward Ms. Merkel? The SPD rank and file are hostile to the chancellor’s leadership style and are infuriated by her tendency to adopt their policies and make them their own.” If the SPD votes NEIN then expect European assets to drop (think DAX, EURO, ITALIAN BONDS). But BUNDS will rally as they are deemed the safest asset class in a political uncertain Europe. Sunday now takes on new importance but be cautious of TWEETS warning of fake headlines and incoming missiles. The trading landscape is fraught with danger.

Third, late last week the EURO currency rallied almost two percent on the release of the ECB minutes from the December 14, 2017 meeting. The minutes reflected a more “hawkish tone,” leading traders to believe that the ECB would be removing QE and leaving NEGATIVE RATES faster than previously anticipated. The problem with this new hawkishness is that it belies the reality of President Draghi’s press conference on December 14, which was considered “very dovish.” The EURO dropped more than one percent following Draghi’s dovish affirmation. The question arises: Does Draghi represent himself or the ECB board? The incongruence is very troubling. Also, if the EURO continues to appreciate will Draghi claim that the strong currency will be a further headwind to inflation? There is far more uncertainty in Europe than market complacency reflects.

Does Euroland really need to manage USD/Euro to preserve its positive trade/ current account balance? To do so, it needs to both accept payment in dollars AND sell Euros against the dollar. Perhaps the Germans have concluded that the losses from this permanent discount are more costly than any loss of sales from an unmanaged exchange rate could be, especially since the U.S. is determined to have NATO become a better customer for the F-35. These are the questions that Yra and others might explore for the benefit of those of us sitting in the bleachers.

Better not sell those F-35’s on credit/finance. European governments have little ability or intention to repay their debts – something currently lost in the unrealistically giddy Euro narrative that misses the bigger picture. That said, in the shorter run the unfolding political drama/instability in the US is increasingly ominous with unpredictable impacts on markets.

As for the trade balance, in a $4T/day currency market it matters less than another broader measure like capital flows. IMO only a fool parks in European assets for anything longer than a temporary trade in what likely amounts to an intermediate counter trend reaction. Time to be thinking about gradually re-accumulating dollars again? Or I offer the unconventional suggestion that dim sum bonds (offshore renminbi govt bonds @4% trading in Hong Kong) might be a more attractive safe haven among financial assets. Especially if Yra is correct that money loves fascism.

Dave –good point but I will each and everyday say the FX trade numbers are fictitious–as I once said to my Deutsche prime broker why is it that the FX market is a 5 trillion market until I need a price on $25 million dollars—-turned red in the face

Stephan, IMO the answer to your question is YES. That’s because Europe and the world needs the US to run trade/current account deficits to grease the Eurodollar system and its global dollar credit expansion. It’s a matter of inflate or die. But the FED doesn’t even monitor, much less consider/model, the huge Eurodollar system because it’s “outside their jurisdiction” in the shadow. But no worries as what can possibly go wrong in shadow banking, right? Well the Eurodollar system is now dysfunctional & burning while Central Banks fiddle elsewhere as did Nero, and like it did for him, it’ll end badly for them too.

I could add that a sharply rising Euro will exacerbate economic problems there and turn the EU economy down hard later (I mean in about 2-4 years, not next month). One fundamental reason why I consider Europe to be in “an intermediate counter trend reaction” like I wrote up above.

Chris–great to have you aboard.Keep it coming and I will remind readers that in order to “replace” Berlusconi the Eurocrats parachuted in the pathetic Mario Monti—that didn’t work but it removed Berlusconi—won’t be as easy this time if the Italian electorate vote in a majority for the right leaning parties.But your input is greatly appreciated as it is important to have knowledge to counteract the narrative of what Bernard would refer to as the house propaganda organs—I care not for political sentiments but rather the opportunity for profitable investments based on a quality analysis of the global political economy